IBOR Transition: What you need to know

31 januari 2019

Significant ef­forts are un­der­way to amend and in so­me ca­ses re­pla­ce the in­ter­bank of­fe­red ra­te (IBOR) for key glo­bal cur­ren­ci­es. In the UK, the Financial Conduct Authority has is­su­ed unequi­vocal sta­te­ments im­plo­ring par­ti­es to con­si­der LIBOR una­vai­lab­le af­ter 2021. In the EU, the Benchmarks Regulation[1] (BMR) has im­po­sed a hard de­ad­li­ne for ad­mi­ni­stra­tors of bench­mark ra­tes wit­hin the EU to re­gis­ter and com­ply with new ru­les on bench­mark ra­te set­ting by 1 January 2020. Existing IBORs will need to be amen­ded to com­ply with the BMR, and tho­se that are not in com­pli­an­ce by the de­ad­li­ne will be sus­pen­ded. This could re­sult in se­ri­ous dis­rup­tion to mar­kets and contractu­al ar­range­ments that ha­ve not ot­her­wi­se put in pla­ce con­ting­en­cy plans.

What is IBOR?

IBOR re­pre­sents a fi­nan­ci­al in­sti­tu­tion’s bor­rowing cost for ob­tai­ning un­secu­red fun­ding of a par­ticu­lar cur­ren­cy and term in the in­ter­bank len­ding mar­ket. Notable IBORs in­clu­de LIBOR for GBP, EURIBOR for EUR and STIBOR for SEK. IBORs are a per­va­si­ve fe­a­tu­re in glo­bal fi­nan­ce contracts, from lo­ans and bonds to de­ri­va­ti­ves (among ot­her things). For ex­amp­le, IBOR of­ten un­der­pins in­te­rest ra­tes in com­mer­ci­al len­ding ar­range­ments and forms the ba­sis for end-of-day va­lues for par­ticu­lar hol­dings in de­ri­va­ti­ve trans­ac­tions.

IBOR re­form and al­ter­na­ti­ve ra­tes

IBOR re­form has be­en a to­pic of di­scus­sion sin­ce re­ports first emer­ged of the mar­ket ma­ni­pu­la­tion of LIBOR in 2008. Like ma­ny IBORs in­clu­ding STIBOR, the ra­te-set­ting me­cha­nism for LIBOR re­li­es on sub­mis­sions from a pa­nel of par­ti­ci­pa­ting banks of trans­ac­tion da­ta (if avai­lab­le) or “ex­pert” esti­ma­tes. The scan­dal re­ve­a­led that de­a­lers con­tri­bu­ting to the LIBOR ra­te-set­ting me­cha­nism we­re col­lu­ding to ma­ke sub­mis­sions that be­ne­fitted their tra­ding po­si­tions, re­sul­ting in do­zens of banks pay­ing out to­tal pe­nal­ti­es of upwards of 10 bil­li­on U.S. Dollars.

The marked decli­ne in the num­ber of in­ter­bank trans­ac­tions has al­so un­der­mi­ned the re­li­a­bi­li­ty of cer­tain IBORs. In so­me ca­ses, re­gu­la­tors ha­ve had to com­pel banks to con­ti­nue to sub­mit ra­tes. However, re­gu­la­to­ry in­ter­ven­tion may be en­ding for so­me IBORs: in 2012, the UK’s Financial Conduct Authority an­nounced that it would no long­er com­pel pa­nel banks to sub­mit ra­tes for LIBOR af­ter 2021 and has sin­ce ac­ti­vely pus­hed mar­ket par­ti­ci­pants to iden­ti­fy a re­pla­ce­ment ra­te. Similarly, un­der the BMR, na­tio­nal aut­ho­ri­ti­es on­ly ha­ve the po­wer to com­pel con­tri­bu­tions (and on­ly for cer­tain cri­ti­cal bench­marks) for a two-ye­ar pe­ri­od.

In the EU, the BMR has tightened the con­trols over how ra­tes are set. The BMR in­clu­des swee­ping prin­ciples for how bench­mark ad­mi­ni­stra­tors, con­tri­bu­tors and users wit­hin the EU ma­nage con­flicts of in­te­rest and im­pro­ve the qua­li­ty of in­put da­ta and met­ho­do­lo­gi­es used in de­ter­mi­ning bench­mark ra­tes. For ex­amp­le, for in­te­rest ra­te bench­marks, ad­mi­ni­stra­tors are requi­red to establish in­de­pen­dent over­sight com­mit­te­es to re­gu­lar­ly scru­ti­ni­se the cal­cu­la­tion met­ho­do­lo­gy, in­put da­ta and wi­der go­ver­nan­ce ar­range­ments. All in­te­rest ra­te bench­marks re­gis­te­red with the BMR are al­so sub­ject to a bi­en­ni­al in­de­pen­dent ex­ter­nal com­pli­an­ce au­dit. Entities that pro­du­ce or con­trol a bench­mark, such as the Swedish Banker’s Association in re­la­tion to STIBOR, in so­me ca­ses ha­ve had to over­haul their in­ter­nal pro­ce­du­res to me­et the­se new requi­re­ments. The BMR’s com­pli­an­ce requi­re­ments al­so ha­ve an ex­tra-ter­ri­to­ri­al im­pact whe­re­by non-EU bench­marks can on­ly be used in the EU if aut­ho­ri­sed un­der the BMR (sub­ject to li­mi­ted ex­cep­tions).

In ad­di­tion to the­se IBOR re­forms, ac­ross all ma­jor ju­ris­dic­tions, wor­king groups we­re for­med to se­lect al­ter­na­ti­ve re­fe­rence ra­tes. Some of the­se al­ter­na­ti­ves in­clu­de the Secure Overnight Funding Rate (SOFR) for USD, the re­for­med Sterling Overnight Index Average (SONIA) for GBP, Tokyo Overnight Average (TONA) for JPY and Swiss Average Rate Overnight (SARON) for CHF. These so-cal­led risk-free ra­tes are ba­sed on histo­ri­cal da­ta and the­re­fo­re less suscep­tib­le to ma­ni­pu­la­tion com­pa­red to the for­ward-loo­king IBORs.

What’s next?

Market par­ti­ci­pants need to be awa­re of the sca­le of their ex­po­su­re to IBORs in their ex­is­ting contractu­al ar­range­ments and should start plan­ning how to re­du­ce their re­li­an­ce on IBORs and tran­si­tion to new al­ter­na­ti­ve ra­tes as they be­come mo­re wi­dely ad­op­ted.

Some is­sues for par­ti­es to con­si­der in­clu­de:

whet­her their le­ga­cy contracts ha­ve suf­fi­ci­ent fall back lan­gu­age to en­su­re that a per­ma­nent end to an IBOR do­es not re­sult in contractu­al dis­rup­tion and fru­stra­tion;

if contractu­al amend­ments are requi­red, what con­sent th­res­holds are requi­red for such amend­ments;

whet­her new risk factors should be in­clu­ded in of­fe­ring docu­ments to ad­d­ress the tran­si­tion from IBOR;

how to ad­d­ress any pri­cing gap between IBOR (which in­clu­des bank cre­dit risk) and an al­ter­na­ti­ve ra­te (ma­ny of which are so-cal­led risk-free ra­tes) and which contractu­al par­ty is best su­i­ted to ab­sorb the dif­fe­rence;

how to match the term pe­ri­ods for IBORs (gi­ven that so­me al­ter­na­ti­ve ra­tes on­ly re­flect the ra­te of over­night trans­ac­tions); and

the po­ten­ti­al im­pact on ac­counting stan­dards.

Parties are al­so ad­vi­sed to mo­ni­tor gui­dan­ce is­su­ed by the re­le­vant re­gu­la­tors and in­du­stry as­so­ci­a­tions such as the Association of Financial Markets in Europe (AFME), Loan Market Association (LMA), and the International Swap and Derivatives Association (ISDA). The Hamilton Banking and Finance team is al­so avai­lab­le to an­swer any ques­tions you may ha­ve.

[1]Regulation (EU) 2016/1011 of the European Parliament and the Council of 8 June 2016 on in­di­ces used as bench­marks in fi­nan­ci­al in­stru­ments and fi­nan­ci­al contracts or to me­a­su­re the per­for­man­ce of in­vest­ment funds and amen­ding Directives 2008/48/EC and 2014/17/EU and Regulation (EU) No 596/2014.